The Real Reason The Buffett Rule Would Raise Only $47 Billion

Janet Novack
,
Forbes Staff
I write from D.C. about tax and retirement policy and planning.

Warren Buffett (Photo credit: Wikipedia)

The Wall Street Journal had a catchy headline on the web yesterday: Rich Would Skirt Buffet Rule. Catchy, but misleading. The grabber head was attached to a story reporting an estimate by Congress’ Joint Committee on Taxation that a Senate bill proposing a 30% minimum tax for millionaires would raise only $47 billion over a decade.

Now I would never underestimate the ability of rich folks to skirt taxes. Indeed, I edited a story in the new issue of Forbes that tells how the chairman of Yelp has a tax free Roth IRA worth at least $95 million and have spent a good part of my career writing about abusive tax shelters. There's also no doubt that a 30% minimum tax would lead some rich folks to take fewer capital gains to keep their income below $1 million or to otherwise make sure they're not stung by this new AMT --an understandable behavioral response that reduces the JCT's revenue estimate.

But that’s not the main reason the estimate for S. 2059, sponsored by Sen. Sheldon Whitehouse (D-RI), is “only” $47 billion. The big reason is that the estimate presumes the Bush era tax cuts are allowed to expire at the end of 2012 (as provided for under current law) and that a new 3.8% Medicare “surtax” on investment income (to help pay for the health insurance subsidies in Obamacare) takes effect as scheduled on Jan. 1, 2013. If both those things happen, the top tax rate on long term capital gains will go from 15% this year to 23.8% (20% plus 3.8%) while the top rate on ordinary dividends (the kind Apple Inc. announced this week it will start paying) will jump from 15% to 43.4% (39.6% plus 3.8%). And that’s even before the scheduled Jan. 1, 2013 return of a provision that shaves the itemized deductions of the better off, effectively adding another 1.2% points to their tax rate. If all those tax hikes take effect, as scheduled, the rich will be paying more anyway, reducing the potential haul from a new 30% minimum tax. According to the Urban-Brookings Tax Policy Center, if the Bush tax cuts don't expire, 36% of millionaire households will pay the new minimum tax; if they do expire, the tax will hit just 19% of those households.

Either way, then, the majority of taxpayers with incomes in excess of $1 million won't need to "skirt" the new tax at all. (Keep in mind that the Whitehouse proposal counts Medicare and Social Security taxes paid by the employee, as well as that new 3.8% surtax, towards the minimum 30% of AGI.) Among those who pay less than 30% are the uberrich, who get most of their income from capital gains. According to an Internal Revenue Service study, back in 1995, when the top long term capital gains tax rate was 28%, the 400 taxpayers with the highest reported incomes paid an average effective tax rate of 30% of AGI. In 1998, after the top long term rate on capital gains was cut to 20%, the top 400 paid 22%. Since the Bush tax cuts of 2003 reduced both the capital gains and dividend rates to 15%, the top 400 have been paying an effective income tax rate of only around 18% of AGI.

So what’s my point? I’ve got three, actually. The $47 billion JCT estimate was released by Senate Finance Committee Ranking Member Orin Hatch (R-Utah) along with a statement declaring that the Buffett rule is “a dog that just won’t hunt” and calling on President Obama to “stop the class warfare and start leading by putting out real proposals to bring down our debt.” What Hatch’s statement glosses over is that Obama, in his most recent budget, proposed a hefty $1.4 trillion in tax hikes (over a decade) on those earning $250,000 or more a year, in large part by letting the Bush tax cuts for the better off expire. The “Buffett rule”—so named because Berkshire Hathaway Warren Buffett has publicly complained that he pays less than his secretary-- is only the rhetorical icing on Democratic proposals to make the wealthy pay a lot more. (Whitehouse, in a statement to Forbes, said that even $47 billion “is real money that could help bring down our deficit" and is "simply the right thing to do.”)

So that's point one: You can raise a good bit of dough by taxing the well-off more (though not nearly enough to solve the nation's deficit problem without some serious entitlement cutting and likely tax increases on the middle class too.)

Point two: If you want to make sure that Buffett pays more than his secretary, you don’t need another silly alternative tax layered on top of the current, insanely complicated, AMT. You need to raise the tax rate on long term capital gains nearer to the top rate on ordinary salary---currently 35% , and scheduled to go to 39.6% in 2013. (The optimum rate for raising revenues from capital gains is probably around 28%, according to economists.)

Point three: The biggest tax hikes are the ones that are already built into the law--assuming Congress does nothing and the Bush tax cuts expire. Whereas Whitehouse's bill has zero chance of becoming law, there's always a slim chance that a gridlocked Congress will allow the Bush tax cuts to expire, affecting taxpayers at all income levels. So start thinking now about ways to manage your future tax liability. (For help, read Tax Bracket Madness by Forbes columnist William Baldwin.)